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Top 6 Factors That Determine the Value of Your Business

Posted by Jane Johnson on Thu, Apr, 16, 2015 @ 10:05 AM

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There are six main factors -- three internal and two external -- that can influence the value of privately held companies:

Internal

  • Quality of the business
  • Projected revenue and cash flow
  • Overall size of the company

External

  • Industry events
  • Cost of and availability of capital in the marketplace
  • Cyclical Market forces

As business owners, while we can exercise control over the internal factors, we have no control over the external factors, which can have a significant impact on business value.

Attributes of a Quality Business

The characteristics of a quality business, which maximize business value, include:

  • A capable management team
  • Lack of owner dependence
  • Strong balance sheet
  • Low customer concentration
  • Written processes and procedures

Other Internal Factors that Impact Business Value

In addition, a company on a growth trajectory that can demonstrate increasing cash flows through new customer acquisition, current customer retention, and increasing market share is always much more attractive to a buyer than one that has shown little growth in the past.

Company size is also a driver of business value, since a prospective buyer assumes a larger company has less risk than a smaller company. A company that has been able to achieve $10M or more in gross revenue while maintaining benchmark or greater margins is viewed as a better opportunity than a company of lesser size. These companies typically possess the characteristics of a quality business, which fueled their growth.

External Factors that Impact Business Value

Sudden, Unforeseen Industry Events

What about the external factors an owner has no control over? It is a fact that entire industries can experience cyclical behavior, just like the overall economy. At different times due to different events, industries can experience contraction, expansion, consolidation, and even explosive growth. Just consider how the events of 9/11 impacted industries related to security and anti-terrorism. These sectors experienced rapid growth after that horrendous attack.

In comparison, look at the cattle industry after the mad cow outbreak and the public fear that ensued, which drove beef prices down and cattle ranchers and related businesses through some very tough times. None of these events was directly under the control of the respective business owners, but they definitely felt the effects of the event.

The Cost of Capital

Another external factor that can have a major effect on business value is the cost of capital and its availability. In times of high interest rates or when the market is strained for capital due to investors sitting on the sideline and lenders tightening their credit policies, business values are negatively impacted. The cost of capital has a direct correlation to the return on investment buyers can achieve, and therefore, they will pay less for their acquisitions. These economic conditions also raise their perceived risk in the investment, which lowers the price they are willing to pay.

Cyclical Market Patterns

There are a number of cyclical patterns that impact business transactions, as noted by author Rob Slee in his acclaimed book, Private Capital Markets. Rob provides a historical table that shows the last three decades and when during each decade it was a seller’s market, a neutral market, and a buyer’s market. These cycles are indicative of external market forces and are agnostic to the internal business characteristics.

Make Sure You’re Prepared When the Time Comes to Sell

Quality businesses will be positioned to take advantage of the selling opportunity when it arises. Many business owners are unaware of the market cycles and as a result, they can miss their prime selling opportunity, and may have to wait for the next cycle. For some owners, this may not be an option. Health or retirement plans may force them to sell in a less-than-optimal cycle resulting in a lower multiple and less transaction value.

There is no substitute for proper preparation and planning. While we cannot control external forces, we can, however, control the internal factors. In addition, being aware of cycles and understanding the external forces and their potential impact can help you maximize your company’s value. Being ready and knowing your optimal exit strategy empowers you to be prepared to cash out, exit your business, and achieve your last great deal.

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Topics: Maximizing Business Value